Episode Transcript
Alyson: ETFs are becoming the predominant vehicle choice for model portfolio manufacturers and providers, whether it's their own ETFs or other ETFs to help build out a diversified portfolio.
Tony: Hello and welcome to the FTSE Russell Convenes. I'm Tony Rochte and I'm excited to speak with Alyson Shupe, who's a partner at Goldman Sachs and leads the global product Strategy team for Goldman Sachs Asset Management and Ravi Goutam, who works for Blackrock and leads the institutional sales team.
So, we're here to talk about ETF trends in the innovation that we're all witnessing. So with that, ETFs have grown dramatically over the past 10 years. Today, global ETF assets surpass 20 trillion at the end of last year. BBH has highlighted that their estimate by 2030 is it'll surpass 30 trillion. So it's a massive growth story.
We saw another study from PwC citing that they believe ETFs could exceed 35 trillion during that same time period. So we want to talk about trends, innovation and what's really going on from 2 experts.
Big picture over the past three to five years, what are the biggest shift in changes you've seen in this accelerating market? Maybe Ravi, I'll start with you.
Ravi: Great. Thanks for having us here, Tony. So when ETFs were first used by Institutional clients, say three to five years ago, the use cases were very different than what we're seeing today. So clients would use ETFs for sort of transitional purposes. They'd use them to equitize cash or bondise cash or compared to them with futures contracts and then say, you know, which one was cheaper or richer. Those were the typical use cases for ETFs.
And now you can look at the use cases change quite dramatically and they're becoming much more long-term holdings or strategic holdings. So, like the state of Tennessee, for example, uses index beta building blocks to generate alpha. They lend ETFs, they tactically trade them. So it's become a much more strategic part of their portfolio. So that's one big trend.
And the second trend that's really changing the ETF landscape is the extensive use of ETFs in model portfolios. And so, ETFs are used extensively inside model portfolios and model portfolios are growing at something like over 20% a year, which is 4 times the rate of the asset management industry. And almost 40 to 60% of ETF flows are coming from model portfolios. So, if you think ETFs are a rocket ship, model portfolios are the jet fuel driving this rocket ship. So that's the two really interesting trends we see.
Tony: You know, that's great. And we'll come back to models in a minute. And I know from your seat, Alyson, looking after, you know, a global business, what are you seeing?
Alyson: So, everything that Ravi just highlighted around the institutional use case has moved from transition to strategic holding. And really what's also happened is essentially any asset with an economic value associated with it, there's probably an ETF for it these days, whether it's digital assets now. So that started to come online with investors being able to use ETFs to get digital assets and cryptocurrency exposure. Also, derivative based strategies, which I will talk a little bit more about as well.
So really it's about expanding the toolkit for investors, whether it's discretionary or institutional portfolio managers, but also retail investors, model port, you know, getting access via model portfolios or via their traditional brokerage accounts online.
They now have a ticker for, for any type of asset they that they place economic value behind.
Tony: Let's go back to kind of portfolio construction and models because you mentioned that and I loved your analogue around really the fuel for the model portfolio. Can you spend a minute on that and, and, and really focus on the wealth side of the equation?
Ravi: Sure. Actually, model portfolios sit in this wonderful space that sort of broad. It sits across both wealth and entity. So the distribution is primarily done on the wealth side through advisors and individual and investors buying it, but the manufacturing is done by asset managers.
So it sits across both these worlds, and the reason model portfolios have been taking off are two or three big reasons.
The first thing is it allows the advisor to bring the best of multiple asset managers through open architecture into a single model. It also allows the advisor to spend more time trying to solve their clients’ problems versus trying to be the portfolio manager. And then it allows them to really scale their businesses nicely.
So, if you look at a model portfolio, the average size of a model portfolio is 3 times that of a mutual fund. The average retention period from model portfolio is 3 times that of a mutual fund. So, in just bang for buck model portfolios are a really great delivery mechanism. And so that's why model portfolios have been really successful. And let me turn that over to Allison to get your thoughts.
Alyson: Yes, we've definitely seen a massive increase in model portfolios to allow financial advisors to scale their practice, spend more time with their clients solving for their needs and outsourcing some of the asset allocation decisions to a professional asset manager.
And ETFs are becoming the predominant vehicle choice for model portfolio manufacturers and providers, whether it's their own ETFs or other ETFs to help build out a diversified portfolio.
Tony: Look, we know each other from the industry. I grew up on the ETF side, you know, building and launching ETF businesses, large global asset managers. One of the things we always look for innovation in product development.
We'll, we'll spend time on that. But at the core, you had to get distribution, right.
Ravi: Totally.
Tony: Can you spend a minute on that and talk about distribution? And you know, RIAs has really helped accelerate the market, you know, in the early days, but now you know, you mentioned a large pension plan here in the US, talk about the dynamics between institutional and you know, some of the model delivery.
Ravi: Of course. So when it comes to model portfolios, when model portfolios first started, the model was pretty simple as in if you build it, they will come. Today that's not the case at all, right? There's over 3000 just target allocation models So you have to really differentiate, and differentiation is becoming a huge part of it.
And the way, you know, model manufacturers are differentiating, it is using a lot more active, a lot more tax overlays and these sorts of things are really making it more attractive for end clients to use model portfolios. So that's one way that's important way that you know clients can find an advantageous model.
The second, to your point in distribution, you have to distribute with specific intent. You just can't launch a model on any platform. You have to launch a particular model for a particular platform. It has to be sort of precise. And so, making sure that it's the right model for the right line base is everything.
And now because of technology, model portfolios have gone from what used to be like off the shelf or one-size-fits-all models to these custom models. And so custom models are going at a multiple of off-the-shelf or you know, a standard models and customization is happening through like I said, tax overlays active and the use of active ETFs within model portfolios has gone substantially like almost 50%. That's something we all love, right, Alyson?
Alyson: Absolutely.
Tony: Just stay on active ETFs for a minute. I saw another study today, active ETFs are approaching 2 trillion estimated to grow to 10 trillion, you know, in the next 5-6 years. How do you think about that? How does BlackRock think about that and GSAM for that matter?
Ravi: I think it's a great opportunity for, again, the clients to generate Alpha two ways. Previously in models most of the alpha was generated through asset allocation. Now with active ETFs, you can generate alpha in two ways, through security selection inside the active ETF and also through asset allocation through, you know, normal asset allocation techniques,
Tony: Through the allocation and the alpha delivery through the model,
Ravi: Through the model exactly
Tony: And, and through the underlying
Ravi: And through the underlying. So you've got both ways of picking up alpha. So that's been a sort of a win-win situation for the end client, the advisor and the asset managers.
Tony: Fixed income ETFs a number of years ago were a massive innovation. Then it was the idea you could launch a gold ETF, right, a physical backed and then it was Bitcoin just a few years ago, we've seen a massive focus in the last couple of years on ETFs using derivatives in portfolio construction.
Goldman Sachs Asset Management recently acquired Innovator and they're a leading provider of defined outcome buffer downside protection on the ETF front. So, could you share a little bit more about what you're doing with Innovator and what the vision is?
Alyson: I will just say, taking a step back, it's been fascinating to watch the evolution of the ETF industry and how quickly this industry has been able to respond to giving clients access to tools that are really, really important to help them solve for specific outcomes in the ETF wrapper.
You mentioned many of them and I think the wave of the derivative ETF growth that we've observed over the last five or so years is coming from a lot of different places.
I think it has been more driven by RIAs and more of like the retail individual investor as they've gotten more comfortable with the idea of using options, whether it's to generate income, so to selling covered call strategies in order to generate additional premium income then they might otherwise not be able to get in the bond markets, for example.
And then also using options as a way to buffer on the downside. And so that growth of just providing outcomes that clients could not otherwise do themselves because the average investor can't just buy an option.
Tony: Right
Alyson: They need a professional money manager to do that. And that's exactly where, where Innovator has obviously really, really cut their teeth and, and led the industry not only in offering ETFs that offer buffers and different types of exposures, but also education.
Education is really, really critical for, for any ETF you have to know what you're buying, regardless of the asset class, but particularly for derivatives, there are different trade-offs that have to be considered.
You need to understand how the exposure is, is being, you know, derived. And there's a, there's a very, very heavy education element that that Innovator and obviously Goldman Sachs as well that we value of bringing that to, to our clients.
Tony: That's exciting. As FTSE Russell, we have a global client business. So we certainly focus on the US, but we have large teams in Europe and in in Asia for the FTSE and the Russell indexes. Is this some, is this a trend you're seeing outside of the US as well this derivative income, you know, usage of option overlay?
Alyson: There's a nuanced answer to the question. Yes. I would say it's still very early days outside of the United States. I would say international ETF markets have tended to lag the US ETF markets in terms of asset growth, product launches, etcetera by, you know, by a few years, but there's certainly a lot of catch up happening.
There are derivative based ETFs that are in market in the UCITs wrapper for offshore investors today. It's still relatively small in terms of the, you know, the absolute assets, but we do, you know it just in our client conversations we are feeling there is more demand there. And in particular in Asia.
Asian investors are really, really focused on high income generation. They don't have a lot of choices right now outside of some traditional high dividend, you know, stock types of ETFs
and then we think that's a really great opportunity.
Tony: So, so we've kind of talked about the past, the present, the innovation distribution models, but where does this go, you know in the next 12, 24,36 months?
Ravi: So, I think as you look into the future, these stock bond correlation has tended to be higher than what people normally like. So there’s still a need in the market for, sort of, all-weather ETFs and you're seeing some of that come into the marketplace a little bit.
And the second reason we also see is that the use of like alternatives, but their liquid also is still very low in model portfolios, it's about 2%. So, I think there's room for a little bit additional innovation in the use of sort of alternatives in model portfolios.
The third thing I'd say is on the ETF side is that there's going to be potentially some kind of private market inclusion inside model portfolios.
And that's got to be very thoughtfully done, very carefully done because it's a different, it's a different beast. But there's lots of work being done in the industry and potentially including private markets in model portfolios, but the plumbing has to be right. There's got to be a huge amount of education like you talked about. Those are sort of two or three sort of trends in the future that we see.
Tony: It's clear to me that these tools are becoming sharper. Obviously, you need, you know, professional advice in, you know, on, on the retail and wealth side, but we know the institutions are, are using these exposures more and more. What are your thoughts the next 12,24,36 months?
Alyson: So, we're, we're super busy with thinking just also globally. So, we mentioned what's happening in, in Europe and Asia. I think that's going to continue to accelerate the adoption of ETFs overseas is going to is going to continue to grow. The point that you made on having sharper tools. At the end of the day, if, if we're not solving problems for investors with an ETF, we're not, we're not doing our jobs right. But if we're solving really, really important problems in the ETF wrapper, that is going to accelerate all the growth.
And I think as, as investors embrace ETFs more and more and have more access, they're also rethinking what they're seeking to achieve by an ETF investment. It may be a traditional asset allocation with a certain risk profile. It may be seeking to achieve a specific outcome, whether it's buffering on the downside, enhancing income or achieving higher growth, whether it's alpha through active management or other types of systematic strategies.
Thinking about it in terms of that specific outcome as opposed to just the access itself,
Tony: Certainly exciting. Well, I want to thank Alyson Shupe and Ravi Goutam. What a great panel and congrats on all the success with both your businesses and I look forward to hearing more. Thank you,
Ravi: Thank you
Alyson: Thank you.
